Jack Parker discusses the philosophy and long-term potential of Bitcoin as a technology and its implications on macroeconomics
***This is not financial advice. Always do your own research before investing in cryptocurrencies.
The global economy is facing unprecedented inflation. UK property is up over 10% in a year, petrol is at an all-time high, and the Bank of England believes inflation could go higher yet. In the US, stock markets are at all-time highs, even though the underlying economy is severely damaged by the pandemic and supply chain disruption.
Elsewhere, the situation is much more dire. In Lebanon, the devaluation of the local currency caused food prices to rise 400%+ between October 2019 and June 2021. It’s got worse since, with most people priced out of healthcare, fuel and other essentials. Inflation in Turkey is 19.5%, in Argentina it’s 48%.
Look at anything, anywhere and prices are rising. Commodities like oil and copper. Shipping. HGV driver wages. Pints of beer.
Inflation erodes the value of our wages and savings. This is especially true when our savings are getting 0% interest at the bank. Trying to save for something expensive like a home feels like you’re running down a tunnel as fast as you can, but the tunnel just keeps getting longer.
So, why is all this happening?
The cost of anything is determined by supply and demand, and while the media have focused on supply chain challenges, there has been another major force at work – the creation of vast amounts of new currency that didn’t exist before the pandemic.
To enable governments to borrow money and keep society functioning through the pandemic (e.g. furlough, US stimulus checks) central banks have been creating, out of thin air, trillions of new dollars, pounds, euros or other currency they control. Even now after the reopening the USA’s Federal Reserve is effectively creating $120 billion of new dollars every single month to buy treasury securities and mortgage-backed securities.
While it’s difficult to define all the types of dollars and dollar-equivalent pieces of paper that exist, some estimate that as much as 40% of all US dollars that have ever existed have been created since the start of the pandemic. The Federal Reserve has actively devalued the dollar to keep the economy afloat.
Slowly but surely (it can take months, even years) these extra dollars, pounds, euros flow into the day-to-day economy. This extra currency enables extra demand, pushing up the prices of everything. It’s not that the real value of everything is going up, it’s that the value of each individual dollar, pound or euro is going down because there are just so many more of them.
Inflation isn’t just a problem for young people trying to eat and save for a house. It’s a problem for companies, pension funds, charities that want to protect the purchasing power of their savings.
The inability to simply put money in a bank and have the purchasing power protected means that organisations have to invest in ever-more speculative assets – real estate, stocks, commodities, whatever they can find – not just to make a greedy profit, but just to protect the real-world value they already had. This is just one reason we see empty luxury properties popping up all around the world and why stocks are at all-time highs.
While it’s highly unlikely to happen in Western democracies today, it’s not impossible for inflation to lead to hyperinflation, when the costs of everything skyrocket and the currency becomes effectively worthless.
The Roman Empire 2000 years ago attempted to raise more money by reducing the amount of silver in its coins, devaluing their currency. This enabled them to create many, many more coins to pay for the running of the ever-growing empire. But this led to extreme inflation and some historians believe this was a contributing factor in the collapse of the empire.
Germany experienced hyperinflation in the 1920s after coming off the gold standard and printing money to pay for the costs of WWI and reparation costs after losing the war. More recent examples include Zimbabwe and Venezuela, in which governments continuously print more new money to keep the system going day by day, but in which it is impossible for anybody to save for anything.
Learning from these lessons, Western governments including the USA and UK used to run on the gold standard. Every dollar or pound represented an amount of physical gold owned by that country, limiting their ability to print ever more new money out of thin air. However, through WWII and the aftermath only the United States remained on the gold standard, and other countries pegged their own currency to the dollar. Finally in 1971, Richard Nixon destroyed any remaining link between gold and the dollar. All major world currencies have since been ‘fiat’ currencies, meaning they are backed only by people’s belief in the system. There is no asset that backs each dollar, pound or euro, and there is no limitation to how much new currency can be created out of thin air. If they wanted to, the Bank of England could create a quadrillion new pounds tomorrow and destroy everybody’s saving.
In 2009 central banks created tons of new currency to help the economy recover from the 2007-08 recession. Against this backdrop a new technology was released online, a new form of money that was designed to restore the qualities of gold for the digital age.
This new form of money consisted of computer code operating on a decentralized network (no one person or organization could ever control it, like open-source software), had a hard cap on the amount that could ever exist (so nobody could just create millions more out of thin air) and could be easily transferred between people, even more easily and quickly than electronic dollars or pounds. That technology, often dubbed ‘Digital Gold’, is Bitcoin.
In its short 11-year lifetime, the value of a single Bitcoin has risen from a fraction of a cent to over $60,000. That’s because even when the demand goes up, the supply can’t increase accordingly. The price has to rise. And the demand is intense, with individuals, businesses and non-profits holding it in their savings. This year, El Salvador became the first country to accept Bitcoin as legal tender. Many other South American countries are exploring doing the same.
But the future of Bitcoin is unlikely to be as a daily form of cash. It’s use case is far stronger as a store of value – effectively a savings account, like gold, the value of which can’t be devalued by a central bank.
The price of Bitcoin today is still highly volatile as it attempts to gain mass adoption, and speculative traders buy and sell it frequently to make a quick profit.
But imagine a future, perhaps a decade or two away, in which billions of people, companies from Tesla to your local butcher and even countries and pension funds all use the Bitcoin network as a store of value.
In this world your savings would continue to grow more quickly than the cost of goods and services, including homes. This deflationary environment would be a radical change to the way our economy operates. There would be disruption, but overall everyone would be incentivised to save more, and consume only what they need or really want.
A world in which the purchasing power of your savings are easily protected is one in which people can work less and retire more comfortably. It’s a world in which short term consumerism is replaced by a mindset of long-term investment, perhaps even a more environmentally sustainable society.
A deflationary economy could also bring about massive consequences, and this Bitcoin Standard worldview is far, far from reality – but a growing community of global users are hoping to make it happen.
Central banks and governments do not want Bitcoin to succeed – they want power to stay in their own hands, through the national currencies they control. Some countries are looking to create their own stable cryptocurrencies as an alternative. Yet Bitcoin is succeeding and is being integrated day by day into the financial system, it’s total market cap recently rising over $1 trillion.
While the price of Bitcoin tomorrow or next week is hard to predict, it’s clear that Bitcoin is no longer just speculative ‘internet money’. The technology has serious implications for who controls money, the ability to store value, and the future of global economics.